Woodward, Inc. (WWD) CEO Tom Gendron on Q2 2019 Results - Earnings Call Transcript

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About: Woodward, Inc. (WWD)
by: SA Transcripts
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Earning Call Audio

Woodward, Inc. (NASDAQ:WWD) Q2 2019 Earnings Conference Call April 29, 2019 4:30 PM ET

Company Participants

Don Guzzardo - Vice President of Investor Relations & Treasurer

Tom Gendron - Chairman & Chief Executive Officer

Bob Weber - Vice Chairman & Chief Financial Officer

Conference Call Participants

Sheila Kahyaoglu - Jefferies

David Strauss - Barclays

Gautam Khanna - Cowen

Christopher Glynn - Oppenheimer

Pete Skibitski - Alembic Global Advisors

Chris Howe - Barrington Research

Michael Ciarmoli - SunTrust

Operator

Thank you for standing by. Welcome to the Woodward, Inc. Second Quarter Fiscal Year 2019 Earnings Call. At this time, I would like to inform you that this call is being recorded for rebroadcast and that all participants are in a listen-only mode. Following the presentation, you will be invited to participate in a question-and-answer session.

Joining us today from the company are Mr. Tom Gendron, Chairman and Chief Executive Officer; Mr. Bob Weber, Vice Chairman and Chief Financial Officer; and Mr. Don Guzzardo, Vice President of Investor Relations and Treasurer.

I would now like to turn the call over to Mr. Guzzardo.

Don Guzzardo

Thank you, operator. We would like to welcome all of you to Woodward's second quarter fiscal year 2019 earnings call. In today's call, Tom will comment on our markets and related strategies, and then Bob will discuss our financial results as outlined in our earnings release. At the end of our presentation, we will take questions.

For those who have not seen today's earnings release, you can find it on our website at woodward.com.

We have again included some presentation materials to go along with today's call that are also accessible on our website. An audio replay of this call will be available by phone or on our website through May 13, 2019. The phone number for the audio replay is on the press release announcing this call as well as on our website and will be repeated by the operator at the end of the call.

I would like to refer to and highlight our cautionary statement as shown on slide 3. As always, elements of this presentation are forward-looking or based on our outlook and assumptions for the global economy and our businesses more specifically. Those elements can and do frequently change. Please consider our comments in light of the risks and uncertainties surrounding those elements, including the risks we identify in our filings.

Woodward adopted the FASB Accounting Standard update number 2014-09, revenue from contracts with customers or ASC 606 effective October 1, 2018 and results for the second quarter and first half of fiscal 2019 including adjusted and organic amounts are presented on that basis except as specifically stated otherwise. Prior period amounts are presented under the previous accounting standard ASC 605.

We believe the impact of adoption of the new standard will not be material for the full fiscal year 2019. However, we believe there will be ongoing quarterly variability of the impacts of ASC 606 for both sales and net earnings. The primary impact of ASC 606 is anticipated to be the inclusion of customer-provided inventory and net sales with no related earnings.

In our first fiscal quarter of 2019, we provided sales and earnings under ASC 606 and 605 in both the narrative and tables of our press release as it was the first period of adoption. In this release and going forward, please refer to the tables included in the press release and our quarterly reports on Form 10-Q filed for 2019. Our prepared remarks today will include both 606 and 605 amounts.

In addition, Woodward is providing financial information as reported under U.S. GAAP and on an adjusted and an organic basis. Please refer to our press release and related tables as well as the appendix of today's presentation for the definitions of adjusted organic and other non-GAAP financial measures. We believe this will help in understanding both historical results and future outlooks.

We also direct your attention to the reconciliations of non-U.S. GAAP financial measures which are included in today's slide presentation and our earnings release and related schedules.

Now turning to our results for the second quarter. Net sales were $759 million for the second quarter of fiscal 2019 compared to $548 million for the prior year quarter. Organic net sales which exclude sales attributable to the L’Orange business were $671 million, an increase of 22% from the prior year quarter.

Net earnings were $78 million or $1.20 per share compared to $38 million or $0.60 per share for the prior year quarter. Adjusted net earnings were $90 million or $1.40 per share compared to adjusted net earnings of $52 million or $0.82 per share for the prior year quarter.

Net cash generated from operating activities for the first half of 2019 was $141 million compared to cash generated of $57 million for the same period of the prior year. Free cash flow was $87 million for the first half of 2019 compared to a free cash outflow of $2 million for the same period of the prior year.

Now I will turn the call over to Tom to comment further on our results, strategies, and markets.

Tom Gendron

Thank you, Don, and good afternoon everyone.

In the second quarter of 2019, we delivered strong results in both our Aerospace and Industrial segments marking a record first half of the year. Aerospace markets continued to be very robust, while previously pressured Industrial markets are improving as expected, particularly in both natural gas and diesel engines.

We are encouraged by recent economic data that drives more confidence and strength in the second half, although some uncertainty still remains. As a result, we are increasing our outlook for the year.

Turning to recent events. We are saddened by the tragedies leading to the grounding of Boeing 737 MAX. We're closely monitoring the situation as the investigation continues to unfold.

At this time, we do not anticipate any significant impact in our planned production rates. We will continue to assess potential impacts related to commercial aftermarket from both initial provisioning and legacy aircraft.

Moving to our Aerospace markets. Our Aerospace segment again delivered superior results driven by demand for new fuel-efficient aircraft and continued strength in global passenger and cargo traffic. Load factors remain at an all-time high, which continues to drive aftermarket volumes.

Defense demand remained strong, particularly for Woodward programs with budgets anticipated to further support incremental military spending. We're seeing healthy activity across most of our Defense markets.

Turning to our Industrial markets, in power generation, the globalization and related shift to natural gas, both power generation and the process industries is accelerating.

Significant infrastructure investments in pipelines, processing plants, LNG tankers, and terminals are substantially increasing the availability and utilization of natural gas as an emissions-friendly source of energy. We believe this will lead to return to growth for Industrial gas turbines.

The tremendous growth in Internet traffic and data storage is also driving demand for data center power generation. Within transportation, natural gas truck orders have been exceptionally strong as the Chinese government's air quality initiatives drive natural gas truck demand.

While we anticipate this overall trend will continue, quarterly variability is possible. Global trade continues to drive strong cargo ship utilization-related aftermarket activity. Additionally, recent emission regulations with respect to marine markets are also supporting new equipment sales.

In oil and gas, rising oil prices are driving increased investment. Growth in rig counts, distribution infrastructure,, and processing is leading to increased market demand. Woodward L'Orange continues to perform very well as a result of healthy markets and solid execution across our end markets.

In summary, our Aerospace segment momentum continues led by the narrow-body ramp and growing global passenger traffic. Our Industrial markets are seeing ongoing improvement as anticipated.

Our strategic investments in Aerospace technology have resulted in significant market share gains, while our investments in world-class manufacturing capability and improved productivity are supporting increased profitability.

Our strategic initiatives with respect to our Industrial businesses and our acquisition of Woodward L’Orange have positioned us to capitalize on improving markets through both sales and earnings growth.

Now, I'll turn it to Bob to discuss our financials in more detail.

Bob Weber

Thank you, Tom. We posted another great quarter. Aerospace segment net sales for the second quarter of fiscal 2019 were $483 million compared to $386 million for the second quarter a year ago, a 25% increase.

Aerospace segment net sales were driven by continued strength across commercial and defense OEM and aftermarket programs. The second quarter of 2019 included $33 million of Aerospace segment net sales related to the adoption of ASC 606, primarily due to customer-provided components.

Commercial aftermarket sales were up 32% compared to the prior year quarter or up 21% on a consistent ASC 605 basis. Woodward commercial aftermarket sales were exceptionally strong for both legacy aircraft and additional provisioning.

For the remainder of the year, we anticipate commercial aftermarket growth to moderate versus the prior year based on the strength of the second half last year and the potential for lower initial provisioning due to the grounding of the Boeing 737 MAX.

Aerospace segment earnings for the second quarter of 2019 were $102 million compared to $75 million for the same quarter in the prior year. Segment earnings for the second quarter of 2019 were increased by $9 million related to the adoption of ASC 606.

The increase in Aerospace segment earnings was predominantly driven by higher sales volume across all market categories, partially offset by increased variable compensation related to our strong financial performance in this first half.

Segment earnings as a percent of segment net sales were 21.1% for the second quarter of 2019 compared to 19.3% in the same quarter of the prior year. Under consistent application of ASC 605, segment earnings as a percent of segment net sales would have been 20.5%.

Turning to Industrial, Industrial segment net sales for the second quarter of fiscal 2019 were $276 million compared to $162 million in the prior year period. Organic Industrial segment net sales for the second quarter of 2019 were $188 million, which excludes sales of $88 million attributable to Woodward L’Orange.

Foreign currency exchange rates had an unfavorable impact on sales of approximately $8 million for the second quarter of 2019. On a constant currency basis, sales would have increased approximately 21%.

Segment sales were powered by the ongoing improvements in reciprocating engines, stability in industrial turbines, and the addition of Woodward L’Orange. Industrial segment earnings for the second quarter of 2019 were $27 million or 9.8% of segment net sales.

Adjusted Industrial segment earnings were $36 million for the second quarter of 2019 or 13.1% of segment net sales, compared to $11 million or 6.6% in the prior year period. Industrial segment earnings growth was driven by the higher organic sales volume and the addition of Woodward L’Orange partly offset by increased variable compensation related to improved financial performance in the first half of the year.

At the Woodward level, R&D and selling, general and administrative expenses were largely in line with our expectations and are increased primarily due to the inclusion of Woodward L’Orange. The effective tax rate for the second quarter of 2019 was 14% compared to 20.9% in the second quarter of 2018. The adjusted effective tax rate for the second quarter of 2019 was 16.7% compared to 22.1% in the second quarter of 2018.

For the first six months of 2019, the effective tax rate was 16.5% compared to 34.1% for the same period of the prior year which included transition impacts of the change in U.S. tax legislation. Removing the transition impacts, the tax rate for the first six months of 2018 was 18.4%. We now expect our 2019 effective tax rate to be approximately 20%.

Looking at cash flows. Net cash generated from operating activities for the first six months of 2019 was $141 million, compared to $57 million for the prior year period. Capital expenditures were $54 million for the first half of 2019, compared to $58 million for the first half of 2018. For the full year, we still expect capital expenditures to be approximately $120 million.

Free cash flow for the first six months of the year was $87 million, compared to an outflow of $2 million for the same period of the prior year. The increase in free cash flow was primarily driven by higher earnings. We continue to anticipate fiscal year 2019 free cash flow to be approximately $300 million.

During the first half of 2019, $62 million was returned to stockholders in the form of repurchased shares and dividends. We accelerated our share repurchase gains -- excuse me, we accelerated our share repurchase plan slightly based on improved performance in the first half and related cash flow.

Lastly I'd like to turn to our fiscal 2019 outlook. As we look ahead to the balance of fiscal 2019, economic uncertainty remains. However, we are encouraged by the strong start to the year and the positive developments we are seeing in our markets, which gives us more confidence going into the second half. As a result, we are raising our guidance for the full year.

Total net sales are now expected to be between $2.8 billion and $2.9 billion for fiscal 2019 with Aerospace sales up approximately 15% and Industrial sales up approximately 35% both as compared to the prior year. This reflects the strength in our markets and the impact of ASC 606 with respect to customer-provided inventory.

Aerospace segment earnings as a percent of segment net sales remained unchanged and expected to be approximately 20%. Adjusted Industrial segment earnings as a percent of segment net sales are still expected to be approximately 14%. Adjusted earnings per share is now expected to be between $4.60 and $4.80, based on approximately 65 million fully diluted weighted average shares outstanding.

This concludes our comments on the business and results for the second quarter of fiscal 2019. Operator, we are now ready to open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Sheila Kahyaoglu from Jefferies. Your line is open.

Sheila Kahyaoglu

Thank you. Good afternoon, guys.

Bob Weber

Hi, Sheila.

Sheila Kahyaoglu

Hi. I guess the first question the commercial aftermarket business was up 21% in the quarter. Can you talk -- can you parse that demand a little bit? What was the initial provisioning driven versus the legacy business? And then how are you just thinking about MAX production going throughout the year?

Bob Weber

I'll give you the split and then Tom can comment maybe on the MAX.

Tom Gendron

Yes.

Bob Weber

You know, initial provisioning, while up obviously significantly is still a relatively small percentage of the overall total. So, the larger element of growth is related to legacy aftermarket, which really represents those fleet dynamics and increased airtime on the aircraft that we’ve got more content on. And -- but initial provisioning is strong and remains so.

Tom Gendron

Yes. I think, Sheila as we're looking at the MAX, I think as many of, the production lines are staying wet. We're still producing at the 52 per month rate. And for the foreseeable future, we think that will hold. Obviously, why we said there's some risk or uncertainty in the second half is if the MAX doesn't come online, there -- I suppose there is a risk to those production rates, but at the moment, we would say initial provisioning is probably the larger of the uncertainty tied to the MAX versus OEM production. That's at least our view at this time.

Sheila Kahyaoglu

Thanks for that color. And then just on L’Orange, it continues to perform well. Can you maybe give a little bit more commentary around where you're seeing the biggest benefit from a revenue synergy perspective or from an end-market perspective there?

A – Tom Gendron

Yes. Well first the integration of L’Orange has gone extremely well. We're ahead of schedule. We're getting to the synergies we were identifying. On top of that, the end markets are still doing well. We're seeing good utilization in the marine market which is driving aftermarket sales. Oil and gas is still performing well, and so those are the primary drivers both OE and aftermarket, and the outlook for the remainder of the year is still -- it's really solid, and it's been performing as anticipated, maybe slightly better than anticipated.

Q – Sheila Kahyaoglu

All right. Thank you.

A – Tom Gendron

Thanks Sheila.

Operator

Our next question comes from the line of David Strauss from Barclays. Your line is open.

Q – David Strauss

Thanks. Good afternoon. The 16% organic Industrial growth in the quarter, could you break that out by end market, power gen versus transportation versus oil and gas what that looks like?

A – Robert Weber

Yes. Quantitatively, you'll see some more detail in the footnote. That's probably the best place to get it. But overall, it was in almost all areas. We saw a lot of strength in large gas, we saw strength in small gas, diesels have been very strong. Wind is probably the -- renewables is the only soft spot really across the board for the Industrial business, so it's kind of as we said in the past year, we expected it to start turning around and that's exactly what we're seeing.

Q – David Strauss

Okay. And then in terms of the guidance, I think the guidance is up $0.10 to $0.20 from the beginning of the year, and I think at the beginning of the year, just taking L’Orange specifically you had said L'Orange was going to be $0.35, and I think last quarter you said it was going to be roughly double that amount in terms of accretion. Is that still right? And if so, what's -- kind of what's the offset within that overall guidance increase?

A – Robert Weber

Yes. I mean the offset is largely still uncertainty. So, second half, we still see some. We've got lots of things going on, obviously as Tom mentioned, on the MAX and so forth impact that may have. You have the overall breakdown of kind of the various pieces of the puzzle pretty much accurate. Last quarter, we said we thought it would probably jump up, L’Orange would go to $0.60 from $0.35. Now, we think we see that plus a little bit from there. So overall it's more the uncertainty than anything.

Q – David Strauss

Okay, thanks guys.

A – Robert Weber

Thank you.

Operator

Our next question comes from the line of Gautam Khanna from Cowen. Your line is open.

Q – Gautam Khanna

Yes, thank you guys. First of all just within the guidance now for the fiscal year what is the aftermarket growth rate assumption?

A – Tom Gendron

Yes. The aftermarket -- you talked commercial aftermarket right, Gautam?

Q – Gautam Khanna

Yes.

A – Tom Gendron

Yes. For commercial aftermarket, we're looking at high-single to low-double digits for the full year. As you get to the second half of the year, we have really high comps versus last year, and we have some uncertainty around the initial provisioning as we discussed earlier.

Q – Gautam Khanna

Right. And just to be clear on the provisioning, it sounds like it's fairly small relative to the overall commercial aero aftermarket. Is there any way to quantify? Is it 10%? Is it 15% of the total after... [multiple speakers]?

A – Robert Weber

Your number is directionally accurate. [multiple speakers] a 10% of the total. So it's not necessarily small. I mean 10% is still -it's a good part, but it's not the majority.

Q – Gautam Khanna

Okay. On the OE shipments related to the new single aisle programs, are you guys -- you talked about the learning curves last quarter. Just curious are they both profitable A320neo shipments and 737 MAX shipments on the engine side and the air frame. Are you planning -- are you tracking to the plan of being kind of at OE average margin at this point [ph] by the end of fiscal year?

A – Tom Gendron

We are. We will -- but just for reference we're continuing to see margin enhancement as we move into 2020 though. So we're not at our target, but we are getting to where we anticipated for fiscal year 2019. And we're continuing to drive improved margin as we go into fiscal year '20.

Q – Gautam Khanna

Okay. And then just last one. I mean is there anything you can speak to about any sort of supply chain response that you've seen? I'm just curious how -- I don't know how many customers you serve on the MAX, but how many different intermediaries you ship to, but have you seen any change in behavior among any of your customers downstream related to the right delivery. How it is?

A – Tom Gendron

Yes. Right now there has been no change in our OEM deliveries, so everybody is still driving to rate. I think as you -- most people are aware of I think the supply chain in total for the MAX is trying to catch up and get on to plan. And so today we have not had any pullbacks from any of the -- from either Boeing, the engine, manufacturers of the Tier 1s that we sell to. So far we're still driving that rate.

Q – Gautam Khanna

And what contractual protections do you guys have in place if any if there is some sort of I don't know what destock, or I mean, is there any provision within your contracts that accounts for this scenario? It's in fact state exported to you for an extended period?

Tom Gendron

No. We are contracted to flex with them.

Gautam Khanna

Okay. But so far no change to cash terms or anything of the sort?

Tom Gendron

No. There is none no. Okay, so like I said at the moment, we're tracking to the production rates. We're watching like everybody, but we're optimistic it will come online in the near future. And this time period we'll then use to catch up on the supply chain's past due. So that's current outlook, but that's why we call it uncertainly and some risk in the second half since we never know what will exactly happen. But at the moment our outlook is consistent.

Gautam Khanna

Okay. Thank you. Appreciate it.

Tom Gendron

You bet.

Operator

Our next question comes from the line of Christopher Glynn from Oppenheimer. Your line is open.

Christopher Glynn

Thanks. Good afternoon.

Tom Gendron

Good afternoon.

Christopher Glynn

So $100 million of revenue beaten in the quarter, congratulations. On the guidance, it implies really for both segments second half revenue's notably a little less than the second quarter rates, that's contrary to your normal seasonality. So just wondering if there are any particular pronounced bullets of revenue that was recognized in the quarter that kind of spikes out from your estimation of the underlying markets or your participation therein?

Tom Gendron

No. What I would say is we're tracking well. We had a real solid first half. We're looking at second half and we're just factoring in some uncertainty. But there really is nothing else pulled in or changed.

So we'd be continuing to address the markets and just reflect some uncertainty as we always look at whether it's the MAX, the renewable market or volatility that we always see in China. Those are the things that could affect the second half but nothing is pulled in.

Christopher Glynn

Okay. And maybe saying that -- asking that a little different way. Was there something in the quarter that developed within the market trends that -- what was the biggest upside from your perspective?

Tom Gendron

We saw, I would say, continuing and strong aftermarket particular in Aerospace. But we also saw good aftermarket in Industrial. China is -- our China end markets, which is covering transportation oil and gas and the power were healthy and actually quite strong. So those led on the positive.

As Bob highlighted earlier, the renewable was kind of pressured, but most our end markets and activity came in strong, possibly a little stronger than we really were anticipating up front. Looking forward, we see the markets continuing strong just with the uncertainty that we've been highlighting that we're watching carefully.

Christopher Glynn

Okay. And in terms of the comment that the shift to natural gas for power gen and processing is accelerating. Wondering if you could just kind of clarify the term processing there. I'm not sure what that refers to. And then just a little more color on the characterization of acceleration.

Tom Gendron

Yes. So what we're really looking at there is one with natural gas, it's -- we've highlighted before, it's a very eco-friendly energy source. So, from an emission standpoint, very positive.

The cost or the pricing on natural gas is quite good today, quite low, so that's driving demand. So the fundamentals are very strong. What we mean by processing would be pipelines LNG, particularly LNG plants both -- on both ends of the supply of LNG and the use of LNG. We're also seeing natural gas being used more because of the price as a feedstock and the petrochemical activities.

So that's where we're seeing the demand to increase for natural gas. We see that continuing with the abundant supply and the pricing. So -- and then we're also seeing higher use in transportation and particularly in Asia. So that's driving further demand. So, that combination is where we're seeing the growth.

Christopher Glynn

Great. Thanks for the color.

Tom Gendron

Yes. You’re welcome.

Operator

[Operator Instructions] And our next question comes from the line of Pete Skibitski from Alembic. Your line is open.

Pete Skibitski

Hi guys.

Tom Gendron

Hi, Pete.

Pete Skibitski

So is providing revenue guidance more difficult or more unpredictable under ASC 606 versus 605? I'm trying to get to -- I'm not sure if can you answer this or not whether the revenue guidance boost was more due to your markets or more due to maybe kind of unpredictable this customer inventory area?

Bob Weber

Yeah. The overall guidance is related to both. So, there is an element of the customer provided inventory. Now that we have a number of quarters under our belt and we have better visibility to that, I would say it's similar to any other forecastable item in terms of how we see that going forward. But the other piece of it is largely the performance overall. And so the combination of those two things are what's causing us to raise the sales guidance.

Peter Skibitski

Okay.

Bob Weber

I don't think it's gotten any more difficult.

Peter Skibitski

Okay. Got it. Okay. And so, you've been confident enough to raise your revenue guidance even with the H2 uncertainly. But you didn't raise your free cash flow guidance. Can you tell us why that was?

Tom Gendron

Well, I think it's because it's a robust free cash flow guidance. So, I think at the moment, we do think it's really a solid number. And at this point, we think that's a good number still.

Peter Skibitski

Okay. Last question. In your first quarter 10-Q the cash statement. You guys didn't disclose all the working capital changes in your cash flow statement like you normally do. Is that also a 606 issue, or is that going to be kind of the norm going forward?

Bob Weber

It will be the norm going forward. It's not necessarily related 606. But just a summarization in the Q.

Peter Skibitski

Okay. Okay. Thanks, guys.

Operator

Our next question comes from the line of Chris Howe from Barrington Research. Your line is open.

Chris Howe

Yes. This is Chris Howe, Barrington Research. Good afternoon and great quarter.

Tom Gendron

Thank you, Chris.

Chris Howe

Had a few questions here. The first, previously this is just for bookkeeping, you had mentioned the enforcement of the regulations in China occurring around July. Has that already occurred, or July is still the expectation?

Tom Gendron

July is when they adopt what they call China VI emission regulations. So that's actual firm date. And they're driving towards that and we expect at this time that those regulations will be adopted in the summertime.

Chris Howe

Okay. And then in terms of L’Orange, you mentioned the integration is going to plan. As we look at full year guidance and perhaps even longer term towards the 2023 targets that you provided at Investor Day, how should we look at the upside here in terms of margins? And what potential there is to go beyond where they are now?

Tom Gendron

We were -- yeah, where we highlighted for industrial margins is to be at 16%-plus. This year, we said we would hit 14%. So, I think we're tracking well. And as we move forward we see line of sight to get into that 16%-plus. So I think that's still holding and that does include the L’Orange business being a part of what's emerging from that.

Chris Howe

Okay. Great. And then my last question. Industrial turbine sales are remained stable. Content is, I assume, is increasing. And renewables, there's still some weakness in that area of the market. Is it still the expectation for renewables and also turbines to inflect more positive as we approach 2020?

Tom Gendron

We fully expect the gas turbine part of it and when we look at our turbomachinery, we have gas turbines, steam turbines to compressors. We definitely see that picking up and moving forward. So, we've seen stabilized and slightly growing in total.

The renewable side or our wind business is a little more pressured. And we've highlighted this in the past, it's more based on our customers’ market share and that we have versus looking at the whole market. And so, we have some pressure there. And just happens to be the programs we're on and our customers' success rate. So that's actually what's driving the renewable side. But on the turbomachinery side, it's turned the corner and we anticipate it to start turning up as we move into 2020.

Chris Howe

Okay. Great. And then one last thing. We're still looking at 6% organic growth within industrial if we exclude L’Orange that for the year?

Tom Gendron

So we're higher than that.

Bob Weber

Yeah. We believe it will be above the 6%, closer to high single.

Chris Howe

Okay. Thank you.

Bob Weber

Yeah. Thank you.

Operator

[Operator Instructions]

And our next question comes from the line of Michael Ciarmoli from SunTrust. Your line is open.

Michael Ciarmoli

Hey, good evening, guys. Thanks for taking the questions. Nice results. Maybe just to stay on that line of questioning. I mean, so, the Industrial organic growth doing a little bit better than expected. It sounds like L’Orange is doing better than expected. What about on the Aerospace side? What's driving the bulk of the upward revision there? I mean, was it just the aftermarket since that update or that outlook has now been updated?

- Tom Gendron

Aftermarket and then the other thing to highlight which we did a little bit in our prepared remarks is our military defense activity is very robust at the moment. And we've seen enhanced sales and our order book is strong and the -- what I would call the RFP, the proposal activity is very strong. So we're seeing a good tailwind from Defense spending, and strong commercial as well. So, basically the Aerospace market is very healthy.

The only big uncertainly out there is the MAX. And like we said, right now it's tracking to production rates. And we're very hopeful to see it get back online soon.

Q – Michael Ciarmoli

Got it and what about just the operating margin aspect of the guidance, I mean you're clearly getting better organic performance. Why aren't you getting any additional operating leverage there?

I would've thought, even with the -- on the Industrial side with that organic piece performing much better the cost you've taken out over the years. And even with Aerospace it sounds like you're still hitting on those learning curves, hinting that you're going to get margin enhancement as these OEM programs commence.

So it seems like to get to that 20% aero margins are just going to be flattish to be flattish. And again lot of uncertainty in Industrial, but it seems like there should be some more leverage in the model given the volume growth you guys are getting.

A – Tom Gendron

I think right now – yeah. I appreciate the comment. I think there are very healthy margins in Aerospace. And it's a combination of aftermarket, Defense and commercial OE mix.

So at right now, we're looking at full year 20%, possibly little stronger but I think it's very healthy. On the Industrial side, we're tracking to the margin improvement as the volume improves. L’Orange is delivering.

So, right now that's our best outlook. But things are on the right track. And as we continue to move forward kind of our model is always to enhance productivity and improve margins. And as we go into 2020, we would expect to see improvement as we get into that time period.

A – Robert Weber, Jr.

One thing on maybe…

Q – Michael Ciarmoli

…Got it.

A – Robert Weber, Jr.

… the accounting of techno side 606 remember we do have increased sales but no margin related to the customer inventory. So that's another headwind to that …

Q – Michael Ciarmoli

Right, right.

A – Robert Weber, Jr.

…increase from 20%.

Q – Michael Ciarmoli

Right, got it, and then, just one more. Accounts receivable looked like they were up pretty significantly sequentially up about $100 million, anything to read into there, anything going on?

A – Robert Weber, Jr.

Yeah. Well, in our Asian natural gas business, if you recall, we have more extensive terms -- extended terms if you will and that was very strong in this first half. So we saw some receivables increase related to that.

We anticipate that that may moderate a little bit in the second half. And that's where some of that incremental second half cash flow comes from as that comes off.

Q – Michael Ciarmoli

Got it, perfect, that’s a lot guys. I appreciate it.

A – Robert Weber, Jr.

Yeah. You're welcome.

Operator

And we do have a question from Pete Skibitski from Alembic. Your line is open.

Q – Pete Skibitski

Yeah. Just a couple of follow-ups guys, on Duarte, is the Duarte relocation completed? I'm just trying to understand if we should expect any more EPS adjustments related to Duarte or not?

A – Tom Gendron

Duarte will be for the most part completed by the end of May.

Q – Pete Skibitski

End of May okay, got it, so maybe one more quarter. Okay.

A – Tom Gendron

Right, we still have some in this quarter, the upcoming quarter.

Q – Pete Skibitski

Got you and then, Tom, I think in the past you talked about tougher comps in the precision weapons area. Is that something that maybe you've been surprised about the demand just continues to be kind of toward?

A – Tom Gendron

Yeah. In our smart weapons area, the demand has been strong. The outlook right now if I -- it can vary. As you guys know with the Defense procurement. But I'm looking out probably another two years of strong demand maybe more. But right now, it's been very healthy and continuing.

Q – Pete Skibitski

Okay. And I appreciate color. Thanks guys.

A – Tom Gendron

Okay.

A – Robert Weber, Jr.

Thank you.

Operator

Mr. Gendron, there are no further questions at this time. I will now turn the conference back to you.

Tom Gendron

Okay. Well, thanks everybody for joining us today. And I appreciate the questions. And we'll look forward to seeing many of you during the next quarter and before our next call. So thanks again for joining. Bye.

Operator

Ladies and gentlemen, that concludes our conference call today.

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